The Best REIT ETF For The Retiree: How To Get A 7% Return Or Better

| About: Vanguard REIT (VNQ)

Summary

Five REIT ETFs with the lowest expense ratios are back tested 5 years for cash payout and share price appreciation.

VNQ offered the best of both worlds over the 5-year period: Growing cash payout and share price appreciation.

REIT ETFs and REIT CEFs were compared in order to choose the very best alternative fund for the retiree who needs a 7% cash return.

This is the third in a series of articles attempting to put together a well-diversified $100 thousand portfolio of CEFs and/or ETFs that will return a minimum of 7% and maintain or enhance principal as well - a portfolio that offers the retiree cash dividends and distributions while continuing to hold on to principal, hoping to keep the money flowing without having to dip into one's capital. You can view the first 2 articles in this series here and here.

The last article attempted to find the best REIT CEF to place in the portfolio. This article is geared toward finding the best REIT ETF and to compare it to the findings in the last article to find best REIT fund after back testing them 5 years. So this article is really the second part of finding the best REIT fund for this portfolio.

Using the ETF Database I chose the 5 ETFs out of the 40 listed for REITs that had the lowest expense ratio. The 5 with the lowest expense ratios that have been in business 5 years or longer were Vanguard REIT ETF (NYSEARCA:VNQ), Schwab U.S. REIT ETF (NYSEARCA:SCHH), SPDR Dow Jones REIT ETF (NYSEARCA:RWR), iShares Cohen & Steers REIT ETF (NYSEARCA:ICF) and Wilshire US REIT ETF (NYSEARCA:WREI). These funds were placed in TD Ameritrade's fund compare chart which can be seen below.

Source: TD Ameritrade Web Site

In the comparison charts above and below, one can see that these ETFs have many of the same characteristics. They all have a high market cap, all have a greater than 7% return over the past year, a low turnover ratio and many of the same REITs as their 10 largest holdings.

Source: TD Ameritrade Web Site

Each of these ETFs are graphed below for the past 5 years starting with VNQ.

Source: Interactive Brokers Web Site

One can readily see that both the disbursements to investors and the price of the ETF grew for VNQ over the 5-year period. For the first year the payout was $2.14 while it was $3.531 for the last year, a 64% increase over the 5-year period. The market price of VNQ ranged from $60.00 to $63.00 at the beginning of the 5-year period and is currently selling for around $85.00 a share, a 37% increase in principal. This REIT ETF grew both the payout and the market price very nicely over the period.

The next graph displays the 5-year price and dividends for SCHH.

Source: Interactive Brokers Web Site

SCHH did not fare as well as VNQ in that payouts only increased from $0.656 in the first year to $0.9836 in the last year. Therefore the distributions rose 49% for the period. The market price of the issue rose from around $29.00 at the beginning of the period to around $42.00 per share currently; a 45% increase.

The next graph displays dividends and price movements for RWR.

Source: Interactive Brokers Web Site

RWR started the 5-year period paying out $2.0657 per share and in the past year it paid $3.4461 which amounts to a 66% increase in the annual payout. The market price of the ETF was around $68.00 per share at the beginning of the period and is currently selling for around $96.00, an increase of 41%.

The next to last graph displays the market price and payouts of ICF for the 5-year period.

Source: Interactive Brokers Web Site

ICF started the 5-year period with an annual payout of $2.20 per share which moved up consistently through the years to $3.6723, an excellent increase of 67%. One could have purchased this ETF at the beginning of the period at $74.00 per share and it would have appreciated to its current price of about $104.00 for an increase of 40%.

The final graph shows the market price and dividends for WREI.

Source: Interactive Brokers Web Site

WREI's payout during the first year of the period was $1.01 and is currently at $1.73. However, this increase in payout is back loaded since it only went up to $1.27 from year 1 to year 4 and then ballooned to $1.73 in year 5. The increase in the distributions was 71% and the increase in the market price was 41% or from $34.00 to $48.00 per share.

The next process is to compare these ETFs to each other and then to compare them to the REIT CEFs from the prior article to determine which of these financial instruments best fits the goals of this portfolio.

The following table was constructed below to help one make an informed decision.

ETF

Curr.

Yld

Yld 5 Yrs ago

Price 5 Yrs ago

Curr Price

Curr Yld if bought 5 Yrs ago

Price Appreciation over 5 Yrs

Payout Appreciation over 5 Yrs

VNQ

4.2%

3.5%

$62.00

$85.00

5.7%

37%

64%

SCHH

2.3%

2.3%

$29.00

$42.00

3.4%

45%

49%

RWR

3.6%

3.0%

$68.00

$96.00

5.1%

41%

66%

ICF

3.5%

3.0%

$74.00

$104.00

5.0%

40%

67%

WREI

3.6%

2.9%

$34.00

$48.00

5.1%

41%

71%

Source: My own workup

A key metric in this table is what the current yield would be if one had purchased the ETF 5 years ago. The reason for this examination was the low cash payouts offered by these ETFs compared to the REIT CEFs examined in the 2nd article. The CEFs clearly offered much higher yields while the ETFs clearly offered much higher market and asset price appreciation than the CEFs. It is clear from the table above that even if one held on to these ETFs for 5 years, the cash payments still did not return 7% although VNQ's came close to 6%.

The question still remains, which REIT CEF or ETF should be used in a portfolio whose goal is to have a 7% cash payout and continue to maintain principal. It is clear that the ETFs listed above do not have the needed cash payout. However, the capital appreciation would allow one to sell some shares to bring the cash return up to 7% and still retain the same principal one had at the beginning. The problem with selling shares is the cost one incurs for brokerage fees which would lower cash returns.

The following table was created using the data from the previous article on REIT CEFs.

CEF

Curr.

Yld

Yld 5 Yrs ago

Price 5 Yrs ago

Curr Price

Curr Yld if bought 5 Yrs ago

Price Appreciation over 5 Yrs

Payout Appreciation over 5 Yrs

RFI

7.3%*

6.0%

$14.50

$13.00

6.6%*

(10%)

9%

RNP

7.8%

7.2%

$16.50

$19.00

9.0%

15%

14%

NRO

6.8%

5.5%

$4.35

$5.30

8.3%

22%

50%

JRS

8.5%

8.0%

$11.10

$11.75

8.2%

6%

4%

RIF

6.7%

4.8%

$17.75

$19.80

7.4%

12%

53%

*Does not include extra payments of $0.75 in 2015

Source: My own workup

Cohen & Steers REIT & Preferred Income Fund, Inc. (NYSE:RNP) was the CEF I considered the best alternative when I wrote the CEF article. That was fine until one of the comments on the article pointed out that half of RNP's investments were placed in preferred stocks that were not REITs. So RNP is not a pure REIT CEF. While I am still fond of RNP because of its low expense ratio, its excellent payout and capital appreciation over the 5-year period, if one is going to stay with a pure US REIT Fund, then one is left with RIF or VNQ as the best alternatives. If one has a long term outlook of over 5 years into the future, then choose VNQ. Eventually it will offer the 7% payout on the original capital and also offer fine capital accumulation over a long period of time based upon historical evidence. If one has a shorter term outlook, then choose RIF since it currently offers an almost 7% payout and has grown its payout year after year over the 5-year period. It does not exhibit the capital appreciation of the ETFs, but it does have the cash payout a retiree needs. If one is not sure, perhaps one could split the amount used for REITs between VNQ and RIF for a balanced approach to one's REIT investments.

RFI, a sister fund to RNP and a pure REIT CEF that has paid over 7% consistently during the 5-year period, was also a contender. Originally it was not considered in the first article because of the 10% market price decline over the 5-year period. However, the asset value of the fund remained fairly constant, and since the fund is selling at a discount to asset value and has been consistently paying over 7% makes it a contender for the portfolio as well.

A cautionary note: just because a fund has functioned in a certain way over the past 5 years does not guarantee that it will perform in the same way in the future. The 5-year back testing only gives one a historical perspective upon which to make an informed decision. However, low fees and intelligent management are likely to give one satisfactory performance over the long run, the very items this back testing should help one ascertain.

The next article in this series will address utility CEF and ETF funds.

Disclosure: I am/we are long RNP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The current prices were taken from the middle of last week. Some of these issues have dropped in price since I did the workup.

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